Friday, February 11, 2011

Inside the Numbers: ISM Reports and the Great Margin Squeeze

Richard Fisher, head of the Dallas Fed, flagged the risk of monetizing government debt and bashed the government for out of control spending. He felt the Fed was now "an accomplice to Congress' fiscal malfeasance" and came out against further Quantitative Easing (QE). He further said he would back Fed tightening at the earliest signs of inflation.

These factoids put the Fed's policy in a vise. If QE2 has succeeded by improving economic activity, there is no need to continue it. If it has driven prices up faster than growth, it would now need to try to put the inflation genie back in the bottle by ending QE and as Fisher noted, tightening instead of loosening.

The Fed talks about how the "wealth effect" can spur recovery, and seems to believe the rising stock market (since the QE2 announcement last August) is responsible for increased spending. Presumably that has contributed to increased spending, especially among the well-off, but more ominously, we have see middle-class consumers increasing spending by pulling money out of savings, as shown in this chart from Econophile, who concludes that the wealth effect and reduction in savings are both ephemeral consequences of QE, not signs of a sustainable recovery:

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Inflation in Egypt was 11% in Jan and 5% in Greece. 27% right before Tiananmen. French and Russian revolutions, Weimer Republic - contraction causes misery & hardship but high prices cause anger & uprising. Relief right around the corner though - dollar is sporting an inverse H & S?

Shouldn't it be difficult for Borders to obtain financing to operate? Why are folks lining up to lend them money? It is like there is a giant "don't ask, don't tell" going on here:

The Wall Street Journal story also said Borders is hearing pitches from Bank of America Corp. and General Electric Co.'s finance arm for $450 million in financing to keep operating under bankruptcy protection.

GE Capital had no comment. Bank of America could not be immediately reached.

Borders has struggled with losses for years as it tries to adapt to a changing book industry. More people are buying books online, at discounters and other stores.

The company reported sales at its namesake superstores open at least a year were down 14.6 percent for the crucial holiday period this year.

Borders has also been playing catch-up in the rapidly growing e-book market. It entered the electronic book market with Canada's Kobo Inc. last year, but that announcement seemed belated after chief rival Barnes & Noble announced its own dedicated e-reader, the Nook, in 2009, and invested heavily in a related online store. Amazon.com's Kindle has dominated the e-reader market.

Borders has cut jobs and closed stores to boost its finances while also shifting its focus from less profitable categories such as music to concentrate more on children's books, toys, stationery and its cafe.

Borders received a commitment for a $550 million credit line from GE Capital in January. But it said at the time it was still considering an in-court restructuring.

The company received a delisting warning from the New York Stock Exchange last week because its stock has not traded above $1 for 30 consecutive days.

Excellent analytical overview Yelnick. I'm not an economic guru, so I try to find those who are -- such as yourself.

I do follow my own charts (technicals), but I have been gaining an appreciation for the fundamentals and those who have a good sense of their effects and direction.

One thing I've slowly come to realize (accept) is that the technical bears have been wrong -- seriously and dramatically wrong. The turn-up since March 2009 is historic. We're in an astonishing bull market. The bulls have been right all along and have been eagerly describing the positive fundamentals -- such as growing company profits.

My current sense (from being more open to both sides of the bull-bear debate) is that inflation may be the next chapter of the financial story. Kudlow, hardly a bear, seems concerned as are many of his guests who have been correctly bullish.

I'm thinking... TBT, QLD, DBA... maybe some USO and even GLD... for this next chapter that is beginning to unfold.

I guess I should add that just because the bulls have been right about the market going up, that doesn't mean this rise is based on a sound foundation. But, a mistake is not separating that while the QE's are artificial and may cause ultimate harmful effects and so on, that the immediate effects are bullish.

The Dow is at 12,200 something... not far from its record high. My guess is it'll challenge (maybe pull back a bit or chop) and then break that record soon enough... within a few months. I'm also guessing this is the target or "attraction point" before the next bifurcation (as I think Yelnick would call it). And that bifurcation will be based on the story line of the next chapter.

With the market corrections in a number of Asian markets, underway since November, I can’t help thinking back to the 1997-1998 Asian currency crisis.

The worries in Asia back then began in Thailand with the collapse of the Thai currency (the baht) and spread to the Philippines, Indonesia, Malaysia, Singapore and throughout the region. It began with worries about currencies but soon evolved into stock market declines in emerging markets, which spread to the major countries of Asia, then into South America, Europe, and finally into the U.S., resulting in the 1998 ‘mini-crash’ in which the S&P 500 lost 18% of its value and the Nasdaq 30% of its value.

An article in 1998 on the website of the International Forum on Globalization began with this statement.

“The swift evaporation of the Asian economic ‘miracle’ probably ranks second only to the unraveling of Soviet socialism as the greatest surprise of the last half century. All at once, convention has turned on its head as South Korea, Thailand, and Indonesia line up for multi-billion dollar bailouts from the International Monetary Fund (IMF). Many of the same institutions and people who recently celebrated the Asian ‘tiger economies’ as the engine for world growth in the 21st century now speak of them as a source of financial contagion.

Many Asian countries followed a three-pronged strategy for attracting foreign capital: liberalization of the financial sector, maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital, and pegging of national currencies to the dollar to reassure foreign investors against currency risk.”

Sound familiar?”

Could the market declines that have been underway since November in Indonesia, Malaysia, the Philippines, Singapore, Thailand, China, India, and Brazil, many now having reached double-digits, and the more recent 12% decline in the Middle East/Africa Index since January, and now the 10% decline in the Latin America Index over the last six weeks, be a sign of another contagion spreading out from its beginning in Asia?

Remember, (just to be clear) the ISM Prices Paid Index is NOT an index based on actual commodity prices, but actually a figure that represents business SENTIMENT regarding future inflation via a survey.

Remember, (just to be clear) the ISM Prices Paid Index is NOT an index based on actual commodity prices, but actually a figure that represents business SENTIMENT regarding future inflation via a survey.

It's a distinction which only really matters if the two (sentiment about future inflation and current commodity prices) are not highly correlated. One would suspect they are, given that the survey respondents' jobs will involve the forecasting of input prices for their production processes.

"I guess I should add that just because the bulls have been right about the market going up, that doesn't mean this rise is based on a sound foundation. But, a mistake is not separating that while the QE's are artificial and may cause ultimate harmful effects and so on, that the immediate effects are bullish."

I think the above is a fair summary and pretty hard to argue against. While i have liked and still like the broad picture painted by Prechter and Dent, their ability to translate their work into price action in the markets on a short to intermediate term basis is poor.

On the plus side prechter forced me to look at the liquidity and safety of my assets and Dent has kept me out of RE (apart from a modest home to live in).

On the negative side, while I haven't lost money, there has been quite an opportunity cost. They have kept me out of the market far more than warranted.

I'm still looking for a 5 to 10 percent correction here, but accept it may not happen until we run up another 10 or 15 percent.

"I guess I should add that just because the bulls have been right about the market going up, that doesn't mean this rise is based on a sound foundation. But, a mistake is not separating that while the QE's are artificial and may cause ultimate harmful effects and so on, that the immediate effects are bullish."

One of the big advantages of being an individual trader is that you don't really have to worry about the market's "foundation". That is for the big boys to worry about because only their selling or buying can actually drive prices in a big way.

If I were to characterize what my trading strategy boils down to it's that I want to be "the smartest of the dumb money". Think about it. Let the "smart money" determine what the top and bottom ticks are likely to be and then find the optimal point to enter after they've done so. The key is to figure out how the "smart money" tells you when they've decided that it's time for the market to start moving in the opposite direction and what the "margin of error" in that decision is. If you can really read a chart, you can see the "fingerprints" of the "smart money" on it and trade accordingly. Does it work every time? No, because the market is constantly reacting to and interpreting new information, so the "smart money" can be thinking one thing at 9:59 AM ET and get you in to a trade and then be thinking something else at 10:01 AM ET because of some economic report and doom your trade to getting stopped out because they've changed their collective mind about where the bottom or top is likely to be. That's because while they are the "smart money", they are not "omniscient money". But, my experience has been that more often than not once my trade triggers (long or short, doesn't matter), it goes on to be profitable, even if there is an immediate or almost immediate reaction against the position. Why? Because that's what the "smart money" wants to happen and they are in there either buying the dip or selling the rally. Who am I to argue? I had one trade go against me immediately after I entered, then go against me for two more days, without hitting my stop and then go furiously in the direction I wanted to and end up nicely profitable. The only reason I could hold in the face of that trade heat is because I have a model of what needs to happen to prove me wrong and it didn't happen.

Most of trading success is having the right model of how prices move in reaction to information which impacts mass psychology. The rest is executing against that model and money management.

'm still looking for a 5 to 10 percent correction here, but accept it may not happen until we run up another 10 or 15 percent.

I have found there are far fewer times when it pays to look for a directional movement of a specific size than there are when it pays to react to a directional movement of a specific size, since, again, it's the "smart money" which creates the reaction to certain price levels to drive prices in the opposite direction. Over the past year, I've seen about half a dozen instances where the charts seemed to indicate a pattern of some level of significance was ending. Contrast that with the fact that I've gotten a trading signal nearly every day. I know you don't trade that frequently, but similar logic which works on an Hourly chart works on a Weekly chart as well, just filtered for the trend bias so that you don't take as many counter-trend trades or you use a lower time frame like the Daily to manage your counter-trend trades so that the market doesn't run away from you in the direction of the trend.

Mr. McNealy: It's not a terribly job-filled recovery. Productivity gains continue to push the need to hire out. A lot of the jobs today are around two areas: government-sponsored green initiatives and the social-networking space.

I'm skeptical that the green jobs are [going to drive the recovery]. So far, the track record's been terrible. That's going to be a challenge for the people here who stuck their neck out to go green.

Then there's social networking, which is a pretty interesting phenomenon. There's a lot of energy there, but that's not a terribly labor-intensive kind of activity. I don't think social networking is the jobs driver.

I see a migration from the early days of the Valley. We aren't doing manufacturing; we aren't doing design; we aren't doing computers. It's all moving to Asia and other places where there are lots of technical engineers who are willing to work at a more reasonable salary because they don't have to spend $3.5 million on a home and pay half of it to taxes.

I think every new transition has created less job opportunity as technology has become very leveraged. I don't think our education system, our regulations, our government policies have kept pace with the changes that technology is driving.
//

If you step back from it all, it's pretty clear that our gubmint's only response to technological change was (and still is) to herd everyone into the building, buying and selling of real estate. That misallocation of resources is going to be with us for a long, long time.

"I have found there are far fewer times when it pays to look for a directional movement of a specific size than there are when it pays to react to a directional movement of a specific size,"

No arguements from me. Up or down with a dynamic stop is the way to go if you have the knowledge and the time.

But the reality of a 401k precludes the opportunity to trade. Ours is with Fidelity. When you take a position, you are expected to hold it for 3 months. If you don't, you get a nasty letter. Do it again within 6 months and they freeze your account. Options are fairly limited.

The Prechter/Dent big picture appears to be steaming to a port near. When you think about all the gubmint gaming of RE over the last 10 years, it is going to be interesting to view that investment class 5, 10 and 20 years from now:

That's been the FED's problem all along. It's caught between a rock and a hard place. If inflation gets out of control because of QE, then they must raise rates to slow inflation which kills economy and deficit soars.

>"I think every new transition has created less job opportunity as technology has become very leveraged. I don't think our education system, our regulations, our government policies have kept pace with the changes that technology is driving."

Groupon has hired 1500 new sales people since they turned down Google's offer in Dec.